To continue our discussion about "Protecting Income against inflation and Creating Wealth", saving from monthly income and investing it in Mutual Funds is most important for our financial health. We need to build a diversified portfolio of different types of Mutual Funds which will protect our hard earned money and will work for us to create wealth.
Before we start, please understand "Why Mutual Funds?" in my previous blog which has basics about "Protecting the Income" before we start "Creating Wealth".
Click here to read the Basics of Personal Finance
Moving on,First, Lets understand the types of mutual funds -
1. Equity Funds
2. Equity Linked Saving Schemes (ELSS)
5. Balanced Funds
4. Debt Funds
5. Thematic Funds
6. Others
1. Equity Funds:
Equity Mutual funds invests your money in Equity markets which means they come with as much risk as the stock market but give better returns in long term. Though Equity MFs invest in equity markets, the risk is relatively lower than investing in stock market directly, for below reasons -
a. Your money in invested by a professional Fund Manager of Fund houses like ICICI Prudential, SBI MF, Axis MF etc.
b. Your money is not invested in one stock but diversified in multiple stocks of different sectors like Banking, IT, Pharma, Automobile etc. which reduces the risk
Which means, if you invest Rs. 10000 in an Equity MF having 10 stocks in its portfolio, your Rs.10000 will be divided and will be invested as per the % allocation of these stocks.
The approach of investing in Equity Mutual Funds depends on what type of Equity MF we choose. They are further divided in below categories
1a. Large Cap or Bluechip Equity Funds:
These Funds are least risky Equity Funds as they invest in Large companies like Tata, Reliance, Infosys, SBI etc which are well established, less volatile and less likely to go bankrupt. On the other hand, as these companies are near the saturation point in stock market or almost achieved it, we should not expect huge profits from them as their scope at stock market is limited. These are recommended for long term Equity investment with less risk appetite.
Top Picks(2023)
UTI Nifty 50 Index Fund
ICICI Pru Bluechip Fund
Canara Robecco Bluechip Fund
1b. Small Cap and Mid Cap Equity Funds:
Small and Mid cap funds are exactly opposite to Large Cap Funds as they invest in Small Cap or Mid Cap companies which are volatile, can go bankrupt but on the other side have good potential of making huge profits. These are High Risk High Return funds as they rise more in rising market but fall more in falling market than Large Cap companies.
Top picks (2023)
Small Cap : Nippon India Small Cap Fund, Quant Small Cap Fund
Mid Cap : Kotak Emerging Equity Fund, HDFC Midcap Fund
1c. Diversified or Multi Cap Equity Funds
These funds invest in both Large Cap and Small-Mid Cap companies as per the allocation in their portfolio to avoid the risk of investing completely in Small-Mid cap but adding them in portfolio to make better profits than Large Cap funds. The investment is diversified in companies across different sectors and market capitalization.
FlexiCap Funds are better alternatives to Large Cap fund recently as they have a small exposure to MidCap and SmallCap sectors as well. As compared to FlexiCap funds, MultiCap funds have to invest atleast 25% in Large, Mid and Small caps each.
Top Picks (2023)
Large & MidCap : SBI Large & MidCap, ICICI Large & MidCap, HDFC Large & MidCap
Flexi Cap : Parag Parikh FlexiCap Fund, HDFC FlexiCap, ICICI FlexiCap Fund
Multi Cap : Quant Active Fund, Nippon India Multicap, ICICI Multicap
2. Equity Linked Saving Schemes (ELSS)
ELSS have grown in popularity because of their inclusion in 80C as a Tax Saving Option with the least lock in period as compared to any other option in 80C like PPF etc. ELSS are Equity Mutual Funds with a lock in period of 3 years and the amount invested every year can be declared in 80C to avail tax benefits.
This is a great investment option to avail tax benefits with least lock in period of 3 years, and more returns than other options in long term.
Top Picks (2023)
Quant Tax Plan, HDFC Tax Saver Fund, Kotak ELSS Fund
3. Balanced Funds
Investing in balanced funds in an ideal way for someone who is investing for the first time. Equity oriented balanced funds have up to 65-70% investment in Equity market and 30-35% in Debt instruments like Government bonds, Corporate bonds, Bank FDs etc.
These funds avoid high risk by moving funds to debt when equity markets are on rise and have made profits, and moving funds to equity when markets are down to buy at lower prices. This is also a good option to invest a lump sum amount as interest rates given by bank FDs and bonds are going down and may not be able to beat inflation rate in future. And if you remember from previous blog, if rate of inflation is more than interest rates of your savings, it reduces the purchasing power of your money.
The best part is, Balanced funds enjoy tax benefits like equity funds i.e. no tax on returns after 1 year.
Top Picks (2023)
ICICI Pru Equity & Debt Fund
HDFC Balanced Fund
4. Debt Funds
Debt funds are no risk funds as they do not invest in equity markets but in debt instruments like government bonds, corporate bonds, Bank deposits etc and give low interest rates like Bank FDs but better post tax returns than FDs.
Debt funds are ideal when you do not want to take any risk with the capital and want to park it in safe instruments. Lump sum amount can be invested in debt funds instead of FDs to get better returns in times when bank interest rates are going down and also to get better post tax returns.
Debt Funds can be Liquid Funds with no lock in period, Ultra Short term and Short Term Funds with very small lock in period, and Long Term debt funds with upto 1 year lock in period.
How Should Your Ideal Portfolio Look Like:
1. To create a well diversified portfolio, one should have an exposure to Equity as well as Debt. Ideally, % allocation to Debt should be equal to your age, rest all should go to Equity for long term.
e.g. for a 30 years old person, 30% of monthly saving should go to Debt and rest to Equity. This is an ideal example though, you should plan according to the time frame and goals with your financial planner.
Tip: Monthly SIP ( Systematic Investment Plan ) is an ideal way to invest in MFs as it gives a flexibility, benefits of power of compounding and inculcates a habit of saving from your monthly income. All MFs provides this facility and ECS can be done from your bank account to the MF account.
2. Number of funds should not be more than 6, as more funds are difficult to manage and more funds does not mean more diversification as different funds in same category may be investing in same stocks. Thus, funds included in the portfolio should belong to different categories as explained above.
3. 1 Large Cap Fund, 1 Balanced Fund, 1 ELSS depending on your 80C investments, 1 Liquid Debt fund to park surplus amount for emergency, 1 Diversified Equity fund and 1 Long term Debt fund forms a good portfolio for a person who can take a moderate risk and wants to invest for long term. We can add a small-mid cap fund at later stage to improve the chances of more returns with slightly more risk.
Tax on Mutual Funds:
Before investing, one should always calculate the post tax returns to compare investment instruments. This is why Mutual funds are one of the most attractive investment modes for many.
Profits made on any asset class is knows as "Capital Gains" which is of 2 types-
Long Term Capital Gains and Short Term Capital Gains.
Lets see how profits on Equity and Debt Funds are taxed according to capital gains definitions.
Equity Mutual Funds: If you redeem after 1 year, profits are considered as Long Term Capital Gains and there is 10% tax on Profit above 1 Lac, i.e. Long Term capital gains from Equity or Equity oriented Mutual Funds, even balanced funds which invest more than 65% in equity.
If you redeem before 1 year, profits are considered as short term capital gains and taxed at flat 15%.
Debt Mutual Funds: Debt funds include liquid, short-term, income, dynamic bond, and gilt funds. It also includes all debt-oriented funds as MIPs and other hybrid non-equity funds. International funds and gold funds also follow the same taxation as debt funds. If debt funds are redeemed before 3 years, profits are added to your income and taxed as per your tax bracket. Long-term capital gains from debt mutual funds are taxed at 20% with indexation and 10% without indexation. Indexation is adjusting the purchase price for inflation. This increases the purchase cost and, thus, lowers the gain for tax calculation.
Do share your feedback in comment section below.
Hope this basic information is enough for you to take your first step towards investing in mutual funds and make use of their wide categories to fulfill your financial goals and create wealth. Good luck in making better investment decisions and for your financial freedom !
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